Whether you pay a professional or file taxes yourself, you should understand the elements of the tax code that apply to your business. We recommend hiring an accountant to help ensure you’re filing accurate tax returns and taking advantage of any deductions.
The tax code can be difficult to grasp, especially for small businesses. The IRS has created a website with many resources to help businesses comply with their federal tax obligations. In this article, you can learn the basics of small business taxes and easily find the resources you need to understand your obligations, potential deductions, and how to file and pay.
Understanding the tax gap
The Internal Revenue Service periodically estimates the tax gap to historically gauge taxpayers’ compliance with their federal tax obligations. Simply put, the tax gap is the difference in the amount of federal tax owed and the amount collected.
Based on the projections for 2017–2019, the latest years for which information is available, the estimated average gross tax gap is projected to be $540 billion per year. The estimates take into account federal taxes due as well as refundable and non-refundable tax credits. The gross tax gap comprises of three components:
- Non-filing – tax not paid on time by those who do not file on time: $39 billion
- Underreporting – tax understated on timely filed returns: $398 billion
- Underpayment – tax that was reported on time, but not paid on time: $59 billion
The associated compliance rate projection is 87%, in line with compliance rates from 2011 onward. As you can see, the largest portion of the tax gap is underreporting. The IRS estimates that much of this total derives from entities like small businesses, or Schedule C filers, whose income is not reported to the government from W-2s or 1099s.
If you don’t want to be part of that $398 billion, that might be enough motivation to file and pay accurately and on time. You also don’t want to open up your business to an IRS audit.
How much does a small business pay in taxes
The amount a small business may pay in taxes depends on many variables. Among these are state tax laws, your business income, and your business structure. There are six major types of businesses:
Sole Proprietorship: Someone who owns an unincorporated business by themselves.
Partnership: A relationship existing between two or more persons who join to carry on a trade or business.
International Business: Foreign businesses with activities in the U.S. or domestic businesses with activities outside the U.S.
Corporation: A legal entity that is separate and distinct from its owners.
S Corporation: Corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
Limited Liability Company or LLC: A corporate structure whereby the members of the company cannot be held personally liable for the company’s debts or liabilities.
What tax obligations do small businesses have?
Your business may be responsible for these kinds of taxes:
- Federal income taxes: these apply to all forms of earning that make up a taxpayer’s taxable income
- State corporate income tax: a percentage that you pay your state government based on your income
- Sales tax: Four states — Delaware, Montana, New Hampshire, and Oregon — have no statewide sales tax, or local sales taxes either. Alaska has no statewide sales tax, but it allows cities and towns to levy sales taxes
- Property tax: if you own land, buildings, vehicles, etc.
- Payroll tax/employment taxes: tax paid to finance social insurance programs
- Excise tax: certain industries are responsible for federal excise tax revenues, collected mostly from sales of motor fuel, airline tickets, tobacco, alcohol, and health-related goods and services. Excise taxes totaled nearly $100 billion in 2019, or 2.9 percent of total federal tax receipts
Small business tax deductions
The taxes you pay also depend on the deductions you can take.
Cost of goods sold: If your business manufactures products or purchases them for resale, you must generally value inventory at the beginning and end of each tax year to determine your cost of goods sold.
Capital expenses: You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called “capital expenses.” Capital expenses are considered assets in your business. In general, you capitalize three types of costs:
- Business assets
- Improvements
- Startup costs: The costs of getting started in business, before you actually begin business operation, are capital expenses. These costs may include expenses for advertising, travel, or wages for training employees. When you go into business, treat all costs you incur to get your business started as capital expenses.
Cost recovery: Although you generally cannot take a current deduction for a capital expense, you may be able to recover the amount you spend through depreciation, amortization, or depletion. Generally, you must capitalize the costs of making improvements to a business asset if the improvements result in a betterment to the unit of property, restore the unit of property, or adapt the unit of property to a new or different use.
Other deductible expenses:
- Healthcare tax credit
- Business use of personal vehicle
- Home office costs
- Professional fees and training
- Equipment and software purchases
- Moving costs
- Hiring veterans
- Charitable donations
Who needs to pay estimated tax?
Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.
Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed. Corporations generally have to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed. You may have to pay estimated tax for the current year if your tax was more than zero in the prior year.
See the worksheet in Form 1040-ES, Estimated Tax for Individuals for more details on who must pay estimated tax. Non-resident aliens use Form 1040-ES(NR) to figure estimated tax.
Note: If you don’t pay enough tax through withholding and estimated tax payments, you may be charged a penalty. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.
To figure out your estimated tax, you must calculate your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. Then make adjustments for changes in your own situation and for any recent changes in the tax laws.
Who doesn’t need to pay estimated tax?
You don’t have to pay estimated tax for the current year if you meet all three of the following conditions:
- You had no tax liability for the prior year,
- You were a U.S. citizen or resident alien for the whole year, and
- Your prior tax year covered a 12-month period
When do I need to file small business taxes?
For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date.
- April 15
- June 15
- September 15
- January 15 of the following year
If a payment is mailed, the date of the U.S. postmark is the date of payment. If the due date for an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next business day.
How do I pay taxes for my small business?
You may pay taxes with Form 1040-ES by mail, or you can pay online, by phone, or from your mobile device using the IRS2Go app. You can also make your estimated tax payments through your online account, where you can see your payment history and other tax records. For additional information, refer to Publication 505, Tax Withholding and Estimated Tax.
The easiest way to pay federal business taxes is to make all your payments through the Electronic Federal Tax Payment System (EFTPS). If it makes more sense to pay your estimated taxes weekly, bi-weekly, or monthly, you can do so as long as you’ve paid the correct amount by the end of the quarter. With EFTPS, you can access a history of your payments, so you know when and how much you’ve already paid.
Corporations must make payment using the Electronic Federal Tax Payment System. For additional information, refer to Publication 542, Corporations.
How your business checking account can help
Some business checking accounts offer features like sub-accounts, which let you separate money for different purposes. Many businesses use sub-accounts to put funds aside for tax payments throughout the year. By keeping your estimated tax payments separate from your operating balances, you can ensure you’ll have enough cash on hand to cover your business tax obligations.
IRS resources
There are a number of IRS resources available to help you approach business taxes with confidence.
Important forms and instructions
Small Business and Self-Employed Tax Center
Online Learning and Educational Products
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